As recently as last month, Terra’s LUNA coin was rated by CoinMarketCap as the seventh-largest cryptocurrency by market capitalisation, and had enjoyed massive growth through 2021 and the early part of 2022. In April, against a backdrop of fairly bearish crypto markets feeling the pinch from the global supply chain issues, the war in Ukraine, and worldwide currency inflation, LUNA was bucking the trend and had pumped to an all-time high of just under $120 (USD) per coin and over $40 Billion Market Cap, yet by May 10th LUNA had slumped to around $40, and by May 13th LUNA had dropped right out of the top 200 crypto assets and was trading, where trading it was still permitted, at fractions of a cent each and around 500 million dollars market cap.
Meanwhile, and perhaps more shockingly for the wider crypto community, Terra’s popular UST stablecoin slipped completely off its peg to the US Dollar and slumped to around $0.15 as investors around the world frantically dumped their stacks of both LUNA and UST. This, in turn, has sent reverberations through the entire crypto market, with BTC, ETH and the rest slumping to lows mostly not seen since 2020. Such a crash is never without accompanying human tragedy, and news stories quickly surfaced of devastated investors losing everything and committing suicide, although the veracity of these claims is currently hard to ascertain.
But where did it all go wrong?
What are Terra, LUNA, and UST?
LUNA is the native token of Terra, a blockchain developed by the Korean firm Terraform Labs. The aim of the Terra blockchain is to create ‘stablecoins’, tokens designed to reside within the decentralised crypto ecosystem but which hold their value by ‘pegging’ it to an existing fiat currency, in most cases the US Dollar. Stablecoins are particularly useful for keeping any profits you take on your crypto within the digital domain, without exposing them to the volatility of the markets. In theory, at least. Stablecoins usually maintain their value by being backed by assets such as gold – The USDC stablecoin, for example, is backed by dollar-denominated assets of at least equal fair value to the USDC in circulation in segregated accounts with US regulated financial institutions. Such accounts are verified publicly by an independent accounting firm. Other stablecoins, however, rely on complex algorithms to maintain their peg to the US dollar. Terra’s UST was just such a stablecoin.
Without going into too much detail, Terra’s UST coin uses LUNA as a counterweight to maintain its peg, through a mechanism of burning and minting. Essentially, UST is burned to mint LUNA, and vice versa, and one can always be swapped for the other at a rate of 1 UST for 1.00 USD worth of LUNA. This means that if the price of UST rises above $1.00 to, say, $1.01, people will swap their LUNA for UST as they can get a 1% profit on every coin, but by burning so much LUNA and minting so much UST, the price of UST falls back and LUNA rises in value. Conversely, if the value of UST falls to $0.99, then holders will swap their UST for the equivalent value of LUNA at 1 UST to 1.00 USD worth of LUNA, making an easy 1% profit again but bringing the price of UST back up to a dollar in the process. And thus, balance is restored and the peg is maintained. Or at least, it was, perfectly happily, until last week.
So where did it all go wrong?
Various factors have been posited as precipitous to last week’s crypto bloodbath, with many industry experts suggesting a concerted attack on the network looks to have taken place. Others have cited the announcement in March from AnchorProtocol, the saving and lending platform in which around 75% of UST was being held, that the excellent 20% interest rate (arguably the main reason many people held UST at all) would be scrapped in favour of a variable rate, as starting the run on both currencies which led to the crash.
For whatever reason, as reported in the Wall Street Journal, large amounts of Terra UST were being withdrawn from the Anchor Protocol, worrying many investors and prompting them to start selling their own UST. Another group of investors used a blockchain project called Curve Finance to swap UST for other stablecoins. Left, right and center, people were flocking to the exits, and as large quantities of UST were burned in exchange for LUNA, this caused the supply of LUNA to balloon, which led to a fall in the value of that coin as spooked investors started dumping their LUNA stacks too and thus the whole thing went into something of a ‘death spiral’. The balancing act between UST and LUNA broke, and it was around this time, if various Reddit threads are to be believed, distraught private investors started Tweeting out their love for their families and throwing themselves off tall buildings.
At the time of writing, the price of LUNA is listed as $0.00030540 on CoinGecko, but with a disclaimer at the top of the page that in reality, it looks as though they have totally lost track of the price of LUNA and actually don’t have a clue.
Where does Terra go from here?
Whether or not either the LUNA coin or its sister-currency UST can be revived is a matter of some speculation. It’s worth noting that the Terra blockchain is still in operation, and teams of developers are still working on it, so many feel that there is hope at least for LUNA as a project. Do Kwon, the creator of TerraUSD and Terra Luna, on Wednesday outlined a rescue plan to address the crash. “I understand the last 72 hours have been extremely tough on all of you – know that I am resolved to work with every one of you to weather this crisis, and we will build our way out of this,” he wrote on Twitter. So far, though, nothing they’ve tried seems to have worked.
And, of course, confidence in UST will be extremely hard to rebuild, even if it does somehow recover its peg. The wider implications for the crypto market as a whole are still being evaluated, but with stablecoins already in the crosshairs of regulators for some time now it’s hard to imagine that this won’t, at least, accelerate the pace of regulatory involvement in digital currency from the powers that be. Whether or not this is a good thing, of course, depends on the people making the regulations.
As Do Kwon himself said in a later tweet, “Short-term stumbles do not define what you can accomplish, it’s how you respond that matters.”
Indeed.
